Frames of reference, the environment, and efficient taxation

The effects of both habit formation and status concerns are analyzed within a model with short-lived households and a long-lived public good, environmental quality. Status seeking induces households to raise consumption of goods and leisure, and pollution, and to lower environmental quality. Habits exacerbate the social costs of status seeking. Efficient tax programs exist and are analyzed. Status seeking and habits are shown to raise efficient consumption and income tax rates. Moreover, an allocation induced by a sequence of short-lived governments is considered. The more important habits and status, to more mistakenly short-lived governments set tax rates relative to efficient rates. However, in case there exists a long-lived institution, when governments are short-lived, the competitive economy can be induced to attain the efficient allocation by a specific tax-transfer program.Received: January 2004, Accepted: September 2004, JEL Classification: H23, D62, D91, Q20Ronald Wendner: I am indebted to Kurt Annen, Karl Farmer, Nicolas Guigas, Christian Klamler, the participants of the Environmental Workshop at Stanford University, and two anonymous referees for insightful debates on a former version of this paper. The author thanks the Economics Department at Stanford University for hospitality provided during the formative stages of this research.